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Save Your Cash for the Future

It is only natural that businesses find creative ways to get your money. In fact, marketing has gotten so good these days, tag lines and phrases such as “you’ve earned it” or “you deserve to treat yourself” make the feeling of spending money good and give it significance.  How many cars do most people “own” over a 5-year period?  How much “stuff” do we have, and do we pay for storage of this “stuff”?  I am not against treating yourself occasionally or businesses finding creative marketing techniques.  But there is nothing wrong with saying no in favor of saving your money.

What is missing from the “saving money” conversation is the truth and fact that one day, you will encounter a financial setback.  This may take the form of a major repair on your home or car, unforeseen medical expense, job loss, sudden death of a loved one, or the need to put a loved one into long term care.  These are not exciting prospects to consider and come with their own set of difficulties or struggles.  But the struggle is compounded when there are no resources available to help you through the issue.  And even with a saving account to battle these challenges, you may end up exhausting all available resources.  But at least you can wade through it in the short term and maybe it gave you back precious time you needed with a loved one.

Saving Solutions

  • IRA & 401k Contributions – During my early 20s, I had the opportunity to really stack away money in both my 401k and IRA.  Plus, the company matched a large portion of 401k contributions.  I didn’t take it seriously and later on; I used my 401k for frivolous things that did not appreciate in value. 

These retirement saving vehicles need to be taken seriously.  They give you the ability to put either pre-tax or post-tax dollars away for retirement and build equity.  The compound effect over time is substantial when you consider the stock market trends.  Refer to the IRS for max contribution limits to your IRA and 401k.  Don’t forget to consult a financial advisor.

  • General Saving Account – Nearly 37% of Americans would need to borrow some funds in some form in order to cover an unintended $1,000 expense according to a Bankrate.com survey during January 2020.  The average unintended expense totaled over $3,500.  While that percentage seems low, consider this was prior to the COVID-19 pandemic and shutdown here in the U.S.  In April, unemployment hit nearly 15%

We generally overlook the significance of having a saving account because banks are not incentivizing consumers to save anymore.  Interest rates are so low, there is barely any margin available for consumers to take advantage of.  But getting a good return rate on a saving account is not the reason to have one.  Quite simply, you need a saving account to manage reserve funds for anything major that can go on including losing your job or being temporarily shut down.  This is not a common occurrence, but the unexpected is always reliable.  My recommendation is carrying 3-6 months in reserves.

  • Your Home’s Equity – The equity in your home seems like a good vehicle for holding that “reserve” account for the unexpected.  But consider this; you must have income to tap into that equity and the market must be ripe with the opportunity to access the cash.  If you lose your job and/or the interest rates dramatically increase the monthly payment, it’s very difficult to justify a cash out refinance or Home Equity Line of Credit. 

Using your home’s equity for reserves should be considered carefully and ideally, you want to access it when you do NOT need it.  “What’s the point of this” you might ask?  Because when you are actively employed and the market supports all-time low mortgage rates, you likely can qualify for a competitive payment that doesn’t break the bank personally by much, depending on how much you take out.  Again, this is something you consider very carefully.  The equity you draw should be used to pay down debt, improve your home, or set up that 3-6-month reserve account discussed.  It’s not meant to be a rainy-day fund when something comes up you want to purchase.

Good financial discipline means planning for the unknown good or bad.  The outcome of that challenge is a little easier to face with some clarity when one of the obstacles is accounted for, reserve assets.  I strongly encourage readers to consider their financial position and ask an honest question; “if I lose my income today, can I support my family or myself for 3-6 months until I find new income”?  If the honest answer is no, then it is time to reduce spending, pay down debt, and consider leveraging your home appropriately to invest into your future. 

The positive side of financial discipline is the freedom you will gain when you are ready to retire or possibly re-invent yourself with starting up a small business.  You may not experience a hardship and that would be outstanding.  You should be thinking about your future in terms of what you want your retirement to look like.  When you have assets, whether liquid or as investments, you gain more flexibility and options in the marketplace.  This is what savings is about.  You owe it to your family and your hard work over the years to be financially secure.

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6 Different Down Payment Sources

I speak with a lot of prospective homebuyers and nearly always get the question “where can my down payment come from”?  It’s a good question because there are specific sourcing requirements regulated by underwriting guidelines with FHA, VA, USDA, and conventional financing.  Down Payments, next to income sourcing, cause the most headaches.  Below is a general idea of where the down payment for your home can come from.

Income Tax Refunds

This time of year is notorious for people thinking of buying a home largely due to anticipated tax refunds.  Tax refunds open the doors for paying down large chucks of debt and/or putting at least the minimum down payment up for buying a home.  This is an acceptable source of funds for down payments.

However, you should have these funds in your possession before you shop for a home.  Unfortunately, you risk deposits and money paid up front for services like a home inspection and appraisal if you start shopping too soon. 

401k Loan & IRA accounts

If your company offers a 401k retirement plan, you should be contributing to it every paycheck.  Over time, your vested balance builds and helps create some sense of retirement savings.  The majority of plans allow you to borrow against your 401k, creating opportunities to consolidate debt at a lower rate or fund the down payment needed for purchasing a home.  Every plan is different, but typically you can borrow up to 50% of your vested balance.  Many homebuyers I speak with do not realize the power of this asset.

Your payments on the loan come directly from your paycheck each pay period and are based on a loan term you set.  In addition, there is no credit check for this loan, and it does not count against you when calculating how much you qualify for because the money borrowed is secured by the balance.  The downside to this is most of the time, the money your loan is backed by may not be invested in the market, causing you to lose earning potential. 

The IRS allows a one-time first-time homebuyer penalty free withdrawal from your traditional IRA account of up to $10,000 for a down payment to purchase a home.  You will likely pay taxes on the money withdrawn, but not the 10% penalty for being less than 59 1/2.   Visit the IRS site for more details.

Gift Funds

Many people are surprised to learn that a family member or spouse can gift you the funds needed for the down payment to purchase a home.  If purchasing a primary residence, that gift can be 100% of the funds needed when it’s a FHA, VA, USDA or conventional loan.  Jumbo financing allows a gift of funds, but usually 5% of the funds needed must come from the borrower. 

If you have a family member willing to gift you the down payment, make sure you speak with your Loan Officer about how they should transfer the funds.  The paperwork gets tedious if you do not follow instructions and can cause anxiety for the donor.  For information concerning taxes & gifts, consult your tax preparer.

Your Money Saved & Small Business Account

Funds that have been seasoned more than 60 days in a bank account can be used for the down payment on a home.  The bank views this as a compensating factor when determining your loan eligibility.  It does not mean you will be denied a loan with the other forms of down payment.  Simply that the bank considers your ability to manage money in your favor for having saved up to buy a home.

If you are self-employed, your business funds can be used as a down payment for a home.  Certain requirements must be met for this to work.  But it is possible.

Cash on Hand

Probably the most common question we get is “can I use my mattress money for the down payment”?  The majority of the time the answer is no.  However, if we can show a pattern of cash withdrawals that add up to the cash you have on hand, then yes, it is possible to use cash on hand.  Certain requirements must be met such as reviewing 12 months of bank statements (or more) to “find” the cash withdrawals.

Trust me, it’s much better to have the other methods serve you with the down payment than this option.  I’ve done it before, and it was extremely time consuming for both the borrower and the underwriter.

1031 Exchanges & Equity on Sale of Home

A 1031 exchange is a tax code that allows the Investor to use the equity of the sale of a home (usually investment property) as the down payment on another home (usually investment property) to avoid paying the capital gains tax on the equity.  In cases where a borrower is selling their primary residence home and the equity is above the maximum allowed where taxes would be due, they can also do a 1031 exchange on the home they are buying.

Most homebuyers won’t need to consider a 1031 exchange.  Yet, there are many circumstances you may decide to sell your current home and use the proceeds of that sale to purchase another home.  You may do this in a simultaneous closing scenario, meaning you do not need to have the cash in your account right away.  Certainly, your Real Estate agent will need to help prepare you accordingly.  But this is an option if you own a home and still need cash for purchasing a home.

 Summary

The list can actually go on with down payment types and sources.  This is a good chunk of the opportunity where a borrower might consider coming up with a down payment.  The amount of down payment needed will be discussed in another post but depends on the loan program, type of loan, investor requirements etc.  In addition, not mentioned are Down Payment Assistant Programs.  For now, use this as a general guide for understanding where you might be able to come up with a down payment.  Reach out if you have a scenario for us to run by!